CHAPTERS
13-16
FINANCING
Part 1: Partnerships
PARTNERSHIPS
From Grade 11
Kinds
General
1.
•
All partners have unlimited liability
Limited
2.
•
Only one partner has limited liability, but the rest
cannot have a role in management.
PARTNERSHIPS
From Grade 11
Pros
Cons

Combining skills and resources
of two or more people

Limited life

Ease of formation

Unlimited liability (in a
general partnership)

Freedom from government
restrictions and regulations

Ease of decision making
FORMING A PARTNERSHIP

A partner’s initial investment should be recorded
at the FAIR MARKET VALUE (not book
value) of the assets at the date of their transfer
to the partnership.

Values assigned must be agreed to by all.
Upon the formation of a partnership,
this personal computer should be
recorded at its FMV of $350 instead
of current book value of $1,800.
ADMISSION OF A PARTNER

The admission of a new partner results in
the legal dissolution of the existing
partnership and the beginning of a new one.

A new partner may be admitted either by:
1. Buying out an existing partner, or
2. Investing assets in the partnership.
PROCEDURES IN ADDING PARTNERS
Admission of Partner through:
Partnership
Assets
1. Buying out an existing partner

This is a personal transaction between an existing partner and
the new partner.

Any money exchanged is the personal property of the
participants and not the property of the partnership.
PROCEDURES IN ADDING PARTNERS
Hello
Partnership
Assets
2. Investment of Assets in Partnership
When a partner is admitted by investment, both total net assets and
total partnership capital change.
When a new partner’s investment differs from the business equity
acquired by him, the difference is a bonus to either
1) the old partners or
2) the new partner.
PROCEDURES IN ADDING PARTNERS

For example, assume a business worth $1,000,000
acquires a new partner. This is now a “new” business
• She added assets of $200,000, but because of the expertise and
extensive client base that she brought with her, she received a
30% stake in the capital of the “new” business. Observe…
Total old capital
$1,000,000
Total new capital
$1,200,000
FMV of her asset invested
Her stake is:
Which works out to be
only $200,000
30%
$360,000
Compare
So the addition of her to the business resulted in a bonus of
$160,000, which was distributed to the new partner for the reasons
mentioned above.
PROCEDURES IN ADDING PARTNERS

The journal entry to record the entry of this partner
would then look like this:
Date
July 31

Particulars
Various Assets Accounts
Partner 1, Capital
Partner 2, Capital
NEW PARTNER, Capital
Debit
Credit
200,000
80,000
80,000
360,000
The old partners take a penalty in order to reward the
$160,000 bonus to the new partner.
PARTNERSHIPS
Income ratios

A partner’s share of profit/loss is determined by the
income ratio, and allocated during closing entries.
The following are typical income ratios:
1.
2.
3.
4.
Fixed ratio, for example 60% and 40%.
A ratio based on each partner’s share of total company
capital.
Salaries to partners.
Interest on partners’ capital balances.
Note: some or all of the above are often combined together
INCOME RATIOS
Division Of Net Income
Sara and Ray are partners. The partnership agreement provides for the
following income ratio:
1) Salary allowances of $8,400 for Sara and $6,000 for Ray
2) Interest allowances of 10% on beginning capital balances, and
3) Split remaining profit equally.
Beginning capital balances: Sara $28,000 and Ray $24,000. The division of this
year’s partnership income of $22,000 is as follows:
SARA
Total Profit
1. Allocate Salaries
Total Profit Remaining
2. Allocate Interest Allowance
Sara, 10% of $28,000
Ray, 10% of 24,000
Total Profit Remaining
3. Allocate Remaining Profit Equally
Division of Profit
8,400
RAY
TOTAL
6,000
22,000
(14,400)
7,600
1,200
1,200
(2,800)
(2,400)
2,400
(2,400)
12,400
9,600
22,000
2,800
2,400
PARTNERSHIPS
Closing Entries – Allocating the Income Ratio

The income ratio determines how much
profit to close out to each partner.

Closing entries are the same for a
partnership except as follows:

When you close out the Income Summary
account, you now have a Capital account
and a Drawings account for each partner.
PARTNERSHIPS
Closing Entries
At year end, a company would make the following entries
Date
Particulars
Debit
Step 1
All Revenues
Income Summary
Step 2
Income Summary
All Expenses
78,000
Income Summary
Sara, Capital
Ray, Capital
22,000
Step 3
Credit
100,000
100,000
78,000
12,400
9,600
(as determined by the income ratio)
Sara, Capital
Sara, Drawings
7,000
Ray, Capital
Ray, Drawings
5,000
7,000
Step 4
5,000
PARTNERSHIPS
Partner’s Capital Statement
KINGSLEE COMPANY
Statement of Partners’ Capital
For the Year Ended December 31, 2003
Capital, January 1
Add: Additional investment
Net income
Less: Drawings
Capital, December 31
Sara
King
$ 28,000
2,000
12,400
42,400
7,000
$ 35,400
Ray
Lee
$ 24,000
9,600
33,600
5,000
$ 28,600
Total
$52,000
2,000
22,000
76,000
12,000
$ 64,000
The equity statement for a partnership is called the statement of
partners' capital. It’s function is to explain changes in
1) Each partner’s capital account and
2) Total partnership capital.
PARTNERSHIPS
Equity Section Of A Balance Sheet
KINGSLEE COMPANY
The statement of
Balance Sheet - partial
partners’ equity
December 31, 2005
is prepared from
Total liabilities (assumed amount)
$ 115,000
the income
Partners’ equity
statement and the
Sara King, Capital
$ 35,400
Ray Lee, Capital
28,600
partners’ capital
Total partners’ equity
64,000
and drawings
Total liabilities and partners’ equity
$ 179,000
accounts. The
balance sheet for
a partnership is the same as for a proprietorship except in the equity
section. The capital balances of the partners are shown in the balance
sheet.
Do Problems:
E13-1
E13-5
P13-4A 3(a-d) only
For (d), journalize the closing entries